Fossil Fuel Assets In Danger Of Being Stranded

Last week in New York, the information provider
Bloomberg unveiled a new product – a tool to allow investors to calculate how much of their money is tied up in assets that are “stranded” because they are carbon-intensive and therefore likely to be hit by tighter regulations, carbon prices or other constraints.

The move reflects the increasing concern of investors that climate change, and in particular the measures that governments will take to tackle it, could create a whole new class of stranded assets. The danger is that the coal, oil or gas reserves that make up the bulk of some companies’ valuations are not as valuable as companies or investors think because they will not be allowed to exploit them.

At the macro level, the InternationalEnergy Agency’s World Energy Outlook 2013 highlighted the danger – current energy consumption puts the world on course for an increase in average temperatures of 3.6°C, far in excess of the 2°C the international community is aiming for. To have any hope of meeting the 2°C, we need to leave two thirds of current
fossil fuel reserves underground, the IEA says.

The organisation also continues to highlight the unsustainability of the world spending half a trillion dollars a year to subsidise fossil fuel use, mostly in the Middle East, Africa and Asia. These subsidies lead to fossil fuels being used wastefully. At the Brussels launch of the WEO, Fatih Birol, chief economist of the IEA, berated countries in the Middle East that burn oil to generate electricity, calling the practice “an economic crime” because it is such a waste of money. “It is like using
Chanel perfume to fuel your car,” he pointed out.

A pledge by the G20 nations to phase out these payments has had little impact so far, but pressure is building as the true cost to economies and government finances becomes apparent. The growing focus on the costs of subsidising renewable energy also, somewhat paradoxically, heaps more pressure on coal, oil and gas subsidies (and nuclear subsidies, for that matter). Renewables subsidies are doing their job – the cost of the technology is falling and levels of support are decreasing along with it, raising some difficult questions for those that insist that support is still needed for fossil fuels.

While the total cost of renewables support is set to increase as more capacity is rolled out, the cost per unit of energy is falling rapidly and already in some places, wind and solar energy are approaching cost competititiveness with more traditional forms of fuel. In Spain, for example, project developer Grupo Enerpro, has just connected to the grid the country’s first utility-scale solar farm to be built without public subsidies, while it was reported earlier this year that it is cheaper to build new wind energy capacity than new coal-fired power stations in Australia.

Meanwhile, in Shanghai, a more immediate threat became obvious as officials warned children and the elderly to stay indoors for seven of the first nine days of December because of the dangers to health of the choking smog enveloping the city. Neither the Chinese people nor their government are going to stand for such conditions for any length of time, meaning a clampdown on coal-fired power stations in the world’s biggest coal user is all but inevitable.

Shanghai boom and gloom (Photo credit: Pedronet)

The main crutch for traditional sources of energy is that only they can provide the continuous baseload power that is needed to keep the lights on. While that is true today, more or less, power stations are built to last three or four decades. Think back 30 years to 1983. The first mobile phone commercial mobile phone had just been introduced. There was no internet and no electric vehicles except for milk floats (in Europe) and golf buggies (the US). Technologies that are now obsolete, such as DVDs, were still more than a decade away from being invented. The Berlin Wall was still going strong and Nelson Mandela would have to wait more than a decade before tasting freedom. Go back a further 10 years and the world was only just getting to grips with the first oil crisis.

A lot can change in 30 years. Look at the technologies and policies that we have now and that could be perfected in years to come that could render coal-fired power or petroleum-fuelled cars obsolete. It’s not just renewable technologies such as wind and solar – there’s smart grids, buildings and appliances, electric (and maybe hydrogen fuel cell) vehicles, energy storage and any number of energy efficiency options.

It is no surprise that a number of the world’s largest companies – including the world’s biggest oil companies – are already factoring in a carbon price of up to $60 per tonne when they consider their future investment plans.

And it is understandable that some investors are nervous about the prospects for fossil fuel assets being able to continue to provide a return in 2040 and beyond. Bloomberg’s move reflects the fact that investors increasingly want to know the carbon exposure of their portfolios – according to the Asset Owners Disclosure Project, 55% of the average pension portfolio is invested in carbon-intensive assets or exposed to climate change risks, but until now investors have largely ignored this. It will be increasingly difficult for them to do so in future.